Tax Tip #2: Home is Where the Profit is

If you’re like me and you have the smallest of small businesses (i.e. the home office), you’re probably hoping to take a nice, juicy deduction for the portion of your rent and utilities that goes towards supporting your home office. Do you want the good news or the bad news first?

Alright, first the bad news: if the income you made working for yourself is less than your total expenses for the year, including the home office portion of your rent and utilities, you cannot take this deduction. In other words, the IRS will not let you deduct the office portion of your home if it operates at a loss. In my case, because I was teaching for most of 2007, I was an employee during those months and not working for myself. Nevertheless, I was also starting a business, so my expenses for the year were about $2,000 more than the income I made working for myself rather than for the school.

Okay, now the good news: the home office deduction rolls over from year to year until your self-employment income exceeds your expenses. That means that in 2008, assuming my business makes a tidy profit, I can deduct the rent and utilities for my home office from 2008 and 2007!

In short, if you have a home office that eventually makes some money you will get your deduction, just maybe not right away. Be careful about the size of the refund you are expecting this year, especially if you started your business in 2007 or finally took it full-time.

What's green, warm and fuzzy all over?

The feeling you get by giving a gift, getting a tax deduction and helping someone start their new business all at the same time.

This week I was introduced to Kiva, a non-profit that allows you to contribute funds to start-up loans for individuals in developing countries. Unlike many of us, who start businesses to have more creative freedom or to be our own bosses, the entrepreneurs in Kiva are mostly starting businesses to get themselves out of poverty.

There are many ways to contribute to Kiva. You can loan money to an entrepreneur directly, donate funds towards Kiva’s operating costs, or purchase a gift certificate for someone else. If you choose to lend funds directly, you can read through the profiles of all of the entrepreneurs and choose the person or group you feel most connected to. Once they have received all the start-up capital they need (usually less than $1000 altogether), you’ll receive updates via their journal entries about how things are going. If the business is a success, you’ll receive your loan payment back.

I think this is a fantastic organization to work with. It’s great karma, fulfills the highest level of “tzedakah,” and makes a thoughtful, tax-deductible gift, which is especially great for colleagues in your small business world.

My, That's a Lovely Deduction. What, This Old Thing?

It’s that time of year again. Time to sort through your shoe box of receipts in preparation for the tax man. As I hack my own path through the jungle of deductions, I’ll be sharing the little truffles of information I dig up along the way. (Oh c’mon, that metaphor was awesome).

Here’s the first: did you know that you can deduct things you use for your business that you bought long before you even had a business? It’s true. If you bought a bookcase for your living room three years ago and this year it migrated to your office, your business “bought” it from you. You can’t deduct the price you originally paid for it, but you can deduct what it’s currently worth on craigslist.

Tip courtesy of accountant Bob Silver, at http://robert-silver.com/info.php?a=selfemploy

Portland and Seattle d*s Biz Lady Meet-ups

Portland and Seattle ladies! Whether you have a successful design business already or are just thinking about making your craft hobby a full-time gig, you have to go to the design*sponge Biz Lady Meet-up.  This is one of the most useful informational events you will ever attend, not to mention one of the best networking opportunities available.  The San Francisco meet-up is what inspired me to start this blog in the first place, so GO GO GO!

The Portland meet-up is tomorrow, February 26th from 7-9pm at Design Within Reach Portland and the Seattle event is on Thursday, February 28th from 7-9 pm at Design Within Reach Seattle.

You’re supposed to RSVP but at this point, the ever gracious Ms. Grace Bonney is letting folks in anyway.  The event is free, but it is polite to bring a snack or drink to share with the group.

The meet-up is structured as a round-robin.  There are four speakers, who will speak about business financials, press and marketing, retail/wholesale, and successfully balancing life and work.  Everyone divides into smaller groups of four and spends about 20 minutes with each speaker before rotating to the next.  Bring a notebook and a lot of business cards with you and get ready to meet a lot of other very cool, like-minded BizMisses.  I met the super funny and very talented Christine Schmidt of Yellow Owl Workshop at the SF event.

I cannot stress the awesomeness of this event enough.  If can go, go.  I promise, you’ll thank me for it.

Getting an EIN: the Easiest Part of Starting a Business

If you’re a sole proprietorship, you need an EIN.  Well, legally you don’t need one, but in a world full of identity thieves, isn’t it nice to be able to keep you social security number to yourself?  As a new business owner, an enormous number of people are asking for it these days. I find it really disconcerting to have to write it on every bank, credit, shipping and merchant service application I fill out.

An EIN, or Employer Identification Number, otherwise known as a Federal Tax ID, does not actually require you to employ anyone to get it. In fact, it’s so easy to get, you’d be a fool not to do it right now.  All you have to do is visit the EIN page on the IRS’s website.  You can apply in five minutes online (though only during certain hours — I have no idea why), and be instantly approved.  You just print your identification page at the end of the process and you can start using it immediately for almost anything (you have to wait two weeks before using it to file your taxes).  The best part?  It doesn’t cost a dime.

One small note: an EIN is not what will allow you buy things wholesale, at least not in the state of California.  For that you need a seller’s permit, which is a whole other kettle of fish, and is the same document that you need to collect sales tax.  This requires more time and money than getting an EIN.

Sales and What Tax?

I had never even heard of use tax until the State of California told me to pay it.

I had recently registered for a seller’s permit, which is a requirement of doing business in California, and which affords you the privilege of collecting sales tax for the state. It’s an awesome racket. I get to work as a tax collector for the state! Without getting paid!! And all I had to do was pay $50 to sign up!!!

Unfortunately, if you want to be able to purchase things for resale, you’ve got to have one of these seller’s permits. It’s the only way to prove you’re a business and not just paying half price for items for personal use. But it also means that at the end of your first year in business, you will receive a deceptively simple-looking form from the state, asking you to hand over your sales and use tax.

The form is only one page long, front and back, but I couldn’t answer even the first question on it. I called my friends Oliver and Eleanor at The Present Group for help. Eleanor tried to walk me through the definition of use tax, but I asked so many follow-up questions that she finally gave up and said, “You really just need to take the class.”

“The class,” it turns out, is the Basic Sales and Use Tax Seminar offered by the California Board of Equalization. If you sell anything for profit within the state of California, you MUST take this class. Nothing I explain in this post will be as helpful as that free seminar and they will walk you through filling out your entire return step by step. However, for the sake of personal edification and to help you understand why you need to take the free BOE seminar, I will try to provide a brief overview of sales and use tax here:

Contrary to popular belief, sales tax is a tax that companies pay for the privilege of being able to conduct business in their state (8.5% in most of California). It is not actually a tax on consumers for the privilege of being able to buy things. Most businesses, however, can’t afford to pay nearly a tenth of all their sales to the state (in addition to regular income and payroll taxes), so they pass the cost on to their customers by simply adding it to the total sale.  Sales tax only applies to taxable goods (most things other than groceries), not services, and does not apply to non-profit organizations. It also only applies to sales that end up within your state of business, so if you sell things online, you only need to pay sales tax for things you ship to addresses within your state.

Filing sales tax forms is complicated because you need to pay sales tax not only to your state, but also to each individual county in which you did business, and every county has its own sales tax rate.  You can also deduct the cost of any sales tax you paid on materials you bought for your business from the amount you owe the government (more on the definition of materials later), since this is technically a resale transaction.

So what the hell is use tax?  Use tax is a tax businesses pay for anything they buy for resale (i.e. without paying sales tax), but don’t, in fact, re-sell to the public.  It is always the exact same rate as sales tax (e.g. 8.5%).

Let’s say, for example, that I buy fleece, buttons, scissors and a marking pencil for making plush meats.  I don’t pay any sales tax when I buy these items because I am buying them wholesale for my business.  The fleece and the buttons eventually end up as plush meats and go to a customer’s house; they have been re-sold.  I therefore collect and pay sales tax for them. The scissors and marking pen, however, stay with me at my studio.  I don’t resell those items, I use them, so I need to pay use tax on them.  This also applies to plush meats I “use” as gifts or promotional items but don’t sell.  (I don’t need to pay income tax on any of this stuff, since it is still a business expense, but more on income tax in another post.)

In the end, you see, anything you buy for your business requires giving the government sales or use tax.  They both cost the same amount, but need to be neatly divided when filing — I have no idea why.  I have only given a brief overview of the rules above. I would never attempt to file a BOE-401 form based on this information, but hopefully it will act as a good primer before taking “the class.”